How will international bank actions help Europe's financial crisis? Q&A

View full sizeThe Associated PressConstriction cranes work in Frances la Defense business district, near Paris Nov. 10. The European Union warned earlier this month that the 17-country eurozone could slip back into recession next year as the debt crisis spins out of control. Today, central banks around the world announced a coordinated effort to meant to control the crisis.

The Fed,
the European Central Bank, the Bank of England and the central banks of
Canada, Japan and Switzerland said they would make it easier for banks
to get dollars if they need them. Stocks soared in response.

Earlier, markets had fallen after the finance ministers of
the 17 countries that use the euro failed to reach an agreement on
resolving the crisis. That means major disputes will now have to be
addressed by European leaders, who will hold their own meeting in
Brussels next week.

Here are some questions and answers about the crisis:

Q: Why the urgency now?

A:
Earlier efforts, like bailouts of Greece, Portugal and Ireland, haven't
convinced investors that European policymakers can or will resolve the
crisis. Jittery investors are demanding that European governments pay
ever-higher interest rates on their bonds. Yields on Italian bonds, for
instance, top 7 percent. That's considered unsustainable. Even Germany,
Europe's economic powerhouse, struggled to sell bonds last week.

Q: Why are higher interest rates such a problem?

A:
They make it harder for governments to pay debts. And they slow growth.
Tax revenue then falls. The cost of unemployment benefits and other
social programs rise. Some countries might abandon the euro, plunging
the continent and perhaps the world's economy into recession.

Q: Why would countries want to jettison the euro and go back to their own currencies?

A:
To become more economically nimble. When they joined together 12 years
ago, the 17 eurozone countries surrendered control of their
interest-rate policies to a new European Central Bank. That meant they
couldn't cut rates to boost their economies. Nor could they reduce the
value of their currencies, to give their exporters an edge. (A lower
currency makes exports cheaper for foreigners to buy.) Abandoning the
euro would let them escape an economic trap.

Q: How did Europe get into this mess?

A:
The euro made it easier to do business across Europe and made the
continent a potent economic bloc. Yet the experiment was flawed.
Countries were harnessed to one another despite different economies and
cultures but still managed their own finances. As long as prosperity
reigned, banks were happy to lend at low rates even to weaker countries
like Greece. The euro meant lenders didn't have to worry about inflation
in individual countries. Greece and others exploited the opening by
borrowing heavily to finance their swelling budgets. But once the Great
Recession hit hard, their debt proved crushing.

Q: Why is a solution so hard?

A:
The ECB and Germany have resisted aggressive action. Many economists
want the central bank to buy the debt of Italy and other struggling
countries. That would push down interest rates and ease those countries'
borrowing costs. The ECB has bought Italian and Spanish bonds. But it's
loath to do so in a big way. The ECB says it must control inflation,
not be a lender of last resort to governments. Germany opposes one idea —
creating joint bonds backed by the whole eurozone — because it fears
its own borrowing costs would surge if it had to borrow jointly with
weaker countries.

Q: What options have European officials considered?

A:
Things that would have been unthinkable just weeks ago. One option
would be to have countries cede control of their budgets to a central
authority. That authority would stop countries from spending beyond
their means. There has also been talk of forming an elite group of euro
nations to guarantee each other's loans. It would require fiscal
discipline from any country that wants to join.

Q: What would happen if some countries left the eurozone?

A:
It could be catastrophic. Depositors would pull money from banks in
weak countries that dropped the euro. Savers wouldn't want their euros
replaced with feeble national currencies. If countries tried to repay
their euro debts with their own currencies, they'd be considered in
default. They'd struggle to borrow. So would corporations. Economists at
UBS estimate that a weak economy that left the eurozone would shrink 50
percent.

Q: Could a strong country like Germany leave the eurozone to avoid the damage?

A:
Not necessarily. Germany's currency would likely shoot up if it did.
Its exports would then become costlier for foreigners. UBS says that if
Germany left the eurozone, its economy would decline 20 to 25 percent.
And the pain would spread. The United States, Asia and others would
suffer if worldwide credit froze and European economies sank into
recession. U.S. companies have poured $2.2 trillion into long-term
investments in Europe like factories and acquisitions. Companies from
Whirlpool to Abercrombie & Fitch to General Motors have reported
sagging sales in Europe.

Q: Can Europe's leaders solve this mess?

A:
Their performance so far doesn't inspire confidence. Some investors are
bracing for a crackup of the eurozone, which a few analysts say could
happen within days, possibly by the time European leaders end their
meeting next week.

The central banks' coordinated move is expected
to ease pressure on the financial system in the short run. But a real
resolution to the crisis involves getting up to 17 countries and the ECB
to agree on a solution. "This is not just a crisis of Greece or this or
that country," says Nicolas Veron, senior fellow at the Brussels-based
think tank Bruegel. "It's a crisis of European institutions."